6

- i

CHAPTER 6. MARKUPS FOR PRODUCT PRICE DETERMINATION

TABLE OF CONTENTS

6.1 INTRODUCTION ................................

................................................................ ........... 6 -1

6.2 MANUFACTURER MARKUP ................................................................

...................... 6 -1

6.3 DISTRIBUTION CHANNEL S ................................................................

....................... 6 -2

6. 3.1 Calculating Markups ................................

................................................................ ........ 6 -3

6.4 PORTABLE DEHUMIDIFIE RS

................................................................ ..................... 6 -3

6.4.1 Methodology for Retailer Markups ................................................................

................. 6 -4

6.4.2 Derivation of Retailer Markup for Portable Dehumidifiers ................................

............. 6 -6

6.5 MARKUPS FOR WHOLE-HOME DEHUMIDIFIERS ................................

................. 6 -7

6.5.1 Methodology for Wholesaler Markups ................................................................

............ 6 -9

6.5.2 Derivation of Wholesaler Markups ................................................................

................ 6 -10

6.5.3 Methodology for Contractor Markups ................................................................

........... 6 -11

6.5.4 Derivation of Markups for Mechanical Contractors ................................

...................... 6 -12

6.5.4.1 Aggregate Markups for Mechanical Contractors ................................

......... 6 -12

6.5.4.2 Mechanical Contractor Markups in the Replacement and First Time

Owner Markets ................................................................

............................. 6 -13

6.5.5 Derivation of Markups for General Contractors ................................

............................ 6 -14

6.6 SALES TAXES ................................

................................................................ ............. 6 -16

6.7 OV ERALL MARKUPS FOR DEHUMIDIFIERS ........................................................ 6 -17

LIST OF TABLES

Table 6.4-1 Four-Firm Concentration Ratio for Major Appliance Sales in Three Retail

Channels ................................

................................................................ ............... 6 -6

Table 6.4-2 Data for Calculating Baseline Markup: Electronics and Appliance Stores ......... 6 -6

Table 6.4-3 Data for Calculating Incremental Markup: Electronics and Appliance

Stores................................

................................................................ .................... 6 -7

Table 6.5-1 Wholesaler Expenses and Markups

................................................................ ... 6 -10

Table 6.5-3 Mechanical Contractor Expenses and Markups Based on Census Data ............ 6 -12

Table 6.5-4 Baseline Markup, All Mechanical Contractors ................................

.................. 6 -13

Table 6.5-5 Baseline Markups for Replacement and First Time Owner Markets, All

Mechanical Contractors ................................................................

..................... 6 -14

Table 6.5-6 Markups for the Replacement and First Time Owner Markets ......................... 6 -14

Table 6.5-8 General Residential Building Contractor Expenses and Markups ..................... 6 -15

Table 6.6-1 Average Sales Tax Rates by Census Division and Large State ......................... 6 -16

Table 6.7 -1 Summary of Markups for Portable Dehumidifiers ................................

............ 6 -18

Table 6.7-2 Summary of Markups for Whole-Home Dehumidifiers ................................

.... 6 -186

- ii LIST OF FIGURES

Figure 6.3.1 Distribution Channel for Portable Dehumidifiers ................................

................ 6 -2 Figure 6.3.2 Distribution Channels for Whole-Home Dehumidifiers ................................

...... 6 -36-1

CHAPTER 6. MARKUPS FOR PRODUCT PRICE DETERMINATION

6.1 INTRODUCTION

To carry out its economic analyses of potential new energy conservation standards for dehumidifiers, the U.S. Department of Energy ( DOE ) must determine the cost to the consumer of both baseline products ( i. e. , products not subject to new energy conservation standards) and more efficient products. There are two types of markups: (1) baseline markups on the direct business costs of products having baseline efficiency (baseline products) and (2) incremental markups on incremental product costs of higher-efficiency products. DOE estimated consumer prices for baseline products b y applying a baseline markup to the manufacturers’ production costs estimated in the engineering analys is

. For products having higher-than-baseline efficiency, DOE

estimated consumer prices b y applying appropriate markups to the incremental manufacturing costs estimated in the engineering analysis.

In the rulemaking for residential dehumidifiers, DOE is considering two product types : portable and whole-home dehumidifiers. The markups applied to the two product types differ because the products generally follow different distribution channels, as discussed below. Both product types, however, will receive manufacturer markups, as described in section 6.3.

DOE has identified five product classes of portable dehumidifiers, and two of wholehome dehumidifiers. In this analysis, DOE assumed that the market saturation rate for each of the seven dehumidifier product classes varies by the geographical regions defined in the 2009
Residential Energy Consumption Survey ( RECS 2009 ) 1 and based on the shipments forecasts for

2019 . Therefore, DOE calculated regional markups for each dehumidifier product class.

6.2 MANUFACTURER MARKUP

A manufacturer applies a markup to transform production costs into a manufacturer selling price (MSP). DOE used the manufacturer’s cost of goods sold (CGS) and gross margin (GM), along with the following equation, to calculate the manufacturer markup ( MU MFG ).

Where:

MU MFG = manufacturer’s markup,

CGS MFG = manufacturer’s cost of goods sold (or manufacturer production cost ), and

GM MFG = manufacturer’s gross margin.6-2

The manufacturer’s CGS plus its GM equals the manufacturer selling price (MSP). Both baseline products and those produced under new energy conservation standards receive the same manufacturer markup.

DOE developed the average manufacturer markup for dehumidifiers by examining the annual U.S. Security and Exchange Commission (SEC) 10-K reports of publicly owned dehumidifier manufacturing companies from 2008 to 2012. DOE currently has no information on the financial performance of manufacturers of whole-home dehumidifier, because most of them

are no t public companies. Because DOE is unable to calculate a separate markup for wholehome units, DOE assumes that their manufacturer markup is the same as that of portable dehumidifiers. Thus DOE determined the manufacturer markup for all seven product classes of

dehumidifiers to be 1.43.

6.3 DISTRIBUTION CHANNELS

The final markups for determining consumer product prices depend on the type of distribution channels through which the products move from manufacturers to purchasers. At each point in the distribution channel, companies mark up the price of a product to cover their business costs and profit margin. In the rulemaking for residential dehumidifiers, DOE is considering two product types, portable and whole-home dehumidifiers. Given the differences in

their applications, the two product types likely follow different distribution channels from manufacturer to end user. Data from the Association of Home Appliance Manufacturers (AHAM) 2 indicate that most portable dehumidifiers are sold through retail outlets, shown as in Figure 6.3

. 1

.

Figure 6.3

. 1 Distribution Channel for Portable Dehumidifiers

Because whole-home dehumidifiers usually are installed as part of the residential cooling and heating system, DOE assume s they follow the same distribution channel as do central air

conditioners and forced-air heating systems. There are two primary markets that determine how those products pass from the manufacturer to the consumer: one the replacement market and the

other first time owners. In the distribution channel for replacements, the manufacturer generally sells the product to a wholesaler, who in turn sells it to a mechanical contractor, who in turn sells

it to the consumer. The distribution channel for first time owners includes an additional step— the general contractor, who buys the product from the mechanical contractor and installs it in the

home for the consumer. Manufacturer Retailer Consumer6-3

Figure 6.3

. 2 illustrates the two primary distribution channels for whole-home

dehumidifiers.

Replacement:

First Time Owner:

Figure 6.3

. 2 Distribution Channels for Whole-Home Dehumidifiers

6.3.1 Calculating Markups

At each point in a distribution channel, companies mark up the price of a product to cover their business costs and profit margin. In financial statements, gross margin (GM) is the difference between the company revenue and the company cost of sales, or cost of goods sold ( CGS ). A company’ s GM includes expenses associated with the distribution channel— overhead costs (sales, general, and administration); research and development; interest expenses; depreciation; taxes—and company profits. To cover costs and to contribute positively to

com pany cash flow, the price of products must include a markup. Products command lower or higher markups depending on company expenses associated with the product and the degree of market competition. In formulating markups for dehumidifiers, DOE obtained data about the revenue, CGS, and expenses of firms that produce and sell portable or whole-home

dehumidifiers.

6.4 PORTABLE DEHUMIDIFIE RS

Consumers generally purchase portable dehumidifiers directly from retailers. Because they do not have to be installed in an air-conditioning or forced-air system, portable

dehumidifiers incur no markups associated with contractors. Manufacturer Wholesaler Mechanical

Contractor Consumer

Wholesaler Mechanical

Contractor General

Contractor Consumer Manufacturer6-4

6.4.1 Methodology for Retailer Markups

DOE based the retailer markups for portable dehumidifiers on financial data for electronics and appliance stores from the 2007 U.S. Census Annual Retail Trade Survey (ARTS), which is the most recent survey that includes industry-wide detailed operating expenses for that

economic sector. 3 DOE organized the financial data into statements that break down cost components incurred by firms in the sector. DOE assumes that the income statements faithfully represent the various average costs incurred by firms selling home appliances. Although electronics and appliance stores handle multiple commodity lines, the data provide the best available indication of expenses for selling portable dehumidifiers.

The baseline markup changes the MSP of baseline products to the retailer sales price. DOE considers baseline models to be products sold under current market conditions ( i.e. , without new energy conservation standards). DOE used the following equation to calculate an average baseline markup ( MU BASE ) for retailers.

Where:

MU BASE = retailer’ s baseline markup,

CGS RTL = retailer’s cost of goods sold (CGS), and

GM RTL = retailer’s gross margin (GM).

Incremental markups are coefficients that relate the change in the MSP of higherefficiency models to the change in retailer sales price. DOE considers higher-efficiency models to be products sold under market conditions having new efficiency standards. The incremental markup reflects the retailer’s increase in a product’s CGS because of new or amended standards.

There is, unfortunately, a lack of empirical data regarding appliance retailer markup practices in response to a product’s cost increase (due to increased efficiency or other factors). DOE understands that real-world markup practices vary depending on the market conditions that

retailers face and on the magnitude of the change in CGS. Pricing in retail stores also may

involve rules of thumb that are difficult to quantify and to incorporate into DOE’s analysis.

Given the uncertainty about actual markup practices in appliance retailing, DOE’ s approach reflects the following key concepts.

1. Changes in the efficiency of goods sold are not expected to increase economic profits. Thus, DOE calculates markups/gross margins to allow cost recovery for retail companies in the distribution channel (including changes in the cost of capital) without changes in company profits.6-5

2. Efficiency improvements affect some distribution costs but not others. DOE sets markups and retail prices to cover the distribution costs expected to change with efficiency, but not the distribution costs that are not expected to change with efficiency.

The approach to incremental markup s is described in more detail in Dale and Fujita. 4 To estimate incremental retailer markups, DOE divides retailers’ operating expenses into two categories: (1) those that do not change when CGS increases because of amended efficiency standards (“invariant ”)

, and (2) those that increase proportionately with CGS (“variant”). DOE

defines invariant costs as including labor and occupancy expenses, because tho se costs likely will not increase as a result of a rise in CGS. All other expenses, as well as net profit, are assumed to vary in proportion to CGS. Although it is possible that some other expenses may not scale with CGS, DOE takes a conservative position that includes other expenses as variant costs. (Note: under DOE’s approach, a high fixed cost component yields a low incremental markup.)

DOE used the following equation to calculate the incremental markup ( MU INCR ) for

retailers.

Where:

MU INCR = retailer’ s incremental markup,

CGS RTL = retailer’s cost of goods sold, and

VC RTL = retailer’ s variant costs.

In developing incremental markups, DOE envisions that retailers cover costs without changing profits. Although retailers may be able to reap higher profits for a time, DOE’ s approach assumes that competition in the appliance retail market, combined with relatively inelastic demand ( i.e., the demand is not expected to decrease significantly in response to a relatively small increase in price), will tend to pressure retail margins back down.

To measure the degree of competition in appliance retailing, DOE estimated the four-firm concentration ratio (FFCR) of major appliance sales in three retail channels: electronics and appliance stores, building materials and supplies dealers, and general merchandise stores. The FFCR represents the market share of the four largest firms in a given sector. Generally, an

FFCR of less than 40 percent indicates that the sector is not concentrated; an FFCR of more than

70 percent indicates that a sector is highly concentrated. a
, b

The FFCR of appliance sales within each retail channel is equal to the sector FFCR times the percent of total sales within each channel accounted for by major appliances. As shown in

Table 6.4 -1 , appliance sales in electronics and appliance stores, household appliance stores,

a University of Maryland University College: http://info.umuc.edu/mba/public/AMBA607/IndustryStructure.html

. b Quick MBA: http://www.quickmba.com/econ/micro/indcon.shtml

.6-6

building materials and supplies dealers, and general merchandise stores have a FFCR less than the 40-percent threshold. The electronics and appliance stores sector includes a subsector titled “household appliance stores.” Because th at subsector includes numerous stores, it has a FFCR of only 21.3 percent.

Table 6.4 -1 Four-Firm Concentration Ratio for Major Appliance Sales in Three Retail

Channels

Sector FFCR (% of

Sector Sales) Percent of Sales

Accounted for by Major Appliances (%) FFCR (% of Major Appliance Sales)

Electronics and appliance

stores 46.3 42.1 19.5

Subsector : household appliance stores 21.3 37.1 7.9

Building material s and supplies dealers 45.9 17.0 7.8

General merchandise stores 73.2 31.6 23.1

Source: U.S. Economic Census. Establishment and Firm Size ( Including Legal Form of Organization ). 2007. *Note: It is assumed that major appliance sales are uniformly distributed within all firms in each sector.

6.4.2 Derivation of Retailer Markup for Portable Dehumidifiers

The 2007 ARTS data for electronics and appliance stores provide total sales data and detailed operating expenses. To construct a complete data set for estimating markups, DOE

needed to estimate CGS and GM . The most recent 2011 ARTS publishes a separate document containing historical sales and gross margin from 1993 to 2011 for household appliance stores. DOE took the GM as a percent of sales reported for 2007 and combined that percent with 2007 ARTS data to construct a complete income statement for electronics and appliance stores to estimate both baseline and incremental markups. Table 6.4 -2 shows the calculation of the baseline retailer markup.

Table 6.4 -2 Data for Calculati ng Baseline Markup: Electronics and Appliance Stores

Business Item Amount ($1,000,000)

Sales 110.673 Cost of goods sold (CGS) 81.234 Gross margin (GM) 29.439 Baseline markup = (CGS+GM)/CGS 1.36

Source: U.S. Census, 2007 Annual Retail Trade Survey

.

Table 6.4 -3 shows the breakdown of operating expenses for electronics and appliance

stores based on the 2007 ARTS data. The incremental markup is calculated as 1.11.6-7

Table 6.4 -3 Data for Calculating Incremental Markup: Electronics and Appliance Stores

Business Item Amount ($1,000,000)

Sales 110,673

Cost of goods sold (CGS) 81,234 Gross margin (GM) 29,439 Labor & Occupancy Expenses ( invariant) Annual payroll 11,714 Employer costs for fringe benefit 1,829 Contract labor costs, including temporary help 154 Purchased utilities, total 623

Cost of purchased repair and maintenance services 369 Cost of purchased professional and technical services 1,164

Purchased communication services 396 Lease and rental payments 3,576 Taxes and license fees (mostly income taxes) 619

Subtotal: 20,444

Other Operating Expenses & Profit ( variant) Expensed equipment 114 Cost of purchased packaging and containers 68 Other materials and supplies not for resale 502 Cost of purchased transportation, shipping, and warehousing services 606 Cost of purchased advertising and promotional services 2,625 Cost of purchased software 159 Cost of data processing and other purchased computer services, except communications + commissions paid 368

Depreciation and amortization charges 1,525 Other operating expenses 2,070 Net profit before tax (operating profit) 958

Subtotal: 8,995 Incremental markup = (CGS + Total Other Operating Expenses and Profit)/CGS 1.11

Source: U.S. Census. 2007 Annual Retail Trade Survey (for sales), and 2011 Annual Retail Trade Survey (for GM and CGS).

6.5 MARKUPS FOR WHOLE-HOME DEHUMIDIFIERS

DOE examined the manner in which wholesaler and contractor markups may change in response to changes in whole-home dehumidifier efficiency levels and other factors. Using the available data, DOE estimated that there are differences between incremental markups on incremental equipment costs of higher efficiency products and the baseline markup on direct

business costs of products with baseline efficiency. Since the whole-home dehumidifiers are6-8

normally handled and installed by the HVAC experts, the data collected for this product are based on HVAC industry.

DOE derived the wholesaler and contractor markups from three key assumptions about

the costs associated with whole-home dehumidifier s. DOE based the wholesaler and mechanical contractor markups on firm-level income statement data, and based the general contractor markups on U.S. Census Bureau data for the residential building construction industry. DOE obtained the firm income statements from the Heating, Air-conditioning & Refrigeration Distributors International (HARDI) 2012 Profit Report and from the Air Conditioning Contractors of America (ACCA) 2005 Financial Analysis. 5

, 6 HARDI and ACCA are trade associations representing wholesalers and mechanical contractors, respectively. DOE used the financial data from the 2007 U.S. Census of Business for developing general contractor markups

in the same form as the income statement data for wholesalers and mechanical contractors. The key assumptions used to estimate markups using these financial data are:

1. Firm income statements faithfully represent the various average costs incurred by

firms that distribute and install whole-home dehumidifiers.

2. Costs can be divided into two categories: (1) costs that vary in proportion to the MSP of dehumidifiers (variant costs); and (2) costs that do not vary with the MSP of dehumidifiers (invariant costs).

3. Overall, wholesale and contractor prices for dehumidifiers vary in proportion to the

wholesaler and contractor costs for dehumidifiers included in the income statements.

In support of the first assumption, the income statements divide firm costs into various expense categories, including direct costs to purchase or install the product , labor and occupancy costs, and other operating costs and profit. Although wholesalers and contractors tend to handle multiple commodity lines, including room air conditioners, furnaces, central air conditioners, heat pumps, and boilers, the HARDI and ACCA data provide the best available indication of the expenses associated with wholesaling or installing dehumidifiers.

Information obtained from the trade literature, and from selected HVAC wholesalers, contractors, and consultants, tends to support the second assumption; this information indicates that wholesale and contractor markups vary according to the quantity of labor and materials used to distribute and install appliances. In the following discussion, DOE assumes a division of costs between those that do not scale with the manufacturer price (labor and occupancy expenses) and those that do (operating expenses and profit).

In support of the third assumption, the HVAC wholesaler and contractor industry is competitive, and consumer demand for heating and air conditioning is inelastic; that is, demand

does not decrease significantly in response to an increase in product price. The large number of HVAC firms listed in the 2007 Census indicates the competitive nature of the market. The 2007 Census lists, for example, more than 700 HVAC manufacturers, 7 5,300 wholesalers of heat pumps and air-conditioning equipment, 8 more than 170,000 general residential contractors, 9 and
91,000 HVAC contractors. 10 Following standard economic theory, competitive firms facing inelastic demand either set prices in line with costs or quickly go out of business. 116-9

DOE concluded that markups for more efficient products are unlikely to be proportional to all direct costs. When the wholesaler’s purchase price of products increases, for example, only

a fraction of the business expenses increases, while the re st may remain relatively constant. If the unit price of a dehumidifier increases by 30 percent because of improved efficiency, for example, it is unlikely that the cost of secretarial support in an administrative office also will increase by 30 percent. Therefore, DOE assumed that incremental markups cover only those costs that scale with a change in the MSP (variant costs ).

6.5.1 Methodology for Wholesaler Markups

Applying the assumptions described above , DOE developed baseline and incremental markups for wholesalers using the firm income statement from the HARDI 2012 Profit Report. Appendix 6A.1 presents the HARDI itemized revenues and costs in full. Baseline markups cover all the wholesaler’s costs (both invariant and variant). DOE calculated the baseline markup for wholesalers using the following equation.

Where:

MU BASE = wholesaler’s b aseline markup,

CGS WHOLE = wholesaler’s cost of goods sold,

GM WHOLE = wholesaler’s gross margin,

IVC WHOLE = wholesaler’s invariant costs, and

VC WHOLE = wholesaler’s variant costs.

Incremental markups are coefficients that relate the change in the MSP of more energy efficient models, or those products that meet the requirements of new energy conservation standards, to the change in the wholesaler sales price. Incremental markups cover only those costs that scale with a change in the MSP (variant costs ). DOE us ed the following equation to calculate the incremental markup ( MU INCR ) for wholesalers.

Where:

MU INCR = wholesaler’ s incremental markup,

CGS WHOLE = wholesaler’ s cost of goods sold, and

VC WHOLE = wholesaler’ s variant costs.6-10

6.5.2 Derivation of Wholesaler Markups

Wholesalers reported median data in the confidential survey that HARDI conducted of

member firms. 3 Table 6.5 -1 summarizes the data as cost-per-dollar sales revenue and cost per dollar of goods (CGS).

Table 6.5 -1 Wholesaler Expenses and Markups

Description Per Dollar

Sales

Revenue ( $ ) Per Dollar

Cost of

Goods ( $ )

Direct cost of product sales ( CGS) 0.737 1.000

Labor expenses ( salaries and benefits ) 0.151 0.205 Occupancy expenses ( rent, maintenance, and utilities ) 0.036 0.049

Other operating expenses (d epreciation, advertising, and

insurance ) 0.055 0.075

Operating profit 0.021 0.028

B aseline w holesaler markup ( MU WHOLE BASE ) 1.357

Incremental w holesaler markup ( MU WHOLE INCR ) 1.103

Source: Heating, Air Conditioning & Refrigeration Distributors International. 2012. 2012 Profit Report (2011 data).

Based on the information in Table 6.5 -1

, direct product expenses (cost of goods sold) represent about $0.74 per dollar sales revenue, so for every $1 wholesalers take in as sales revenue, $0.74 is used to pay CGS . Labor expenses represent $0.1 5 per dollar of sales revenue; occupancy expenses represent $0.04; other operating expenses represent $0.06; and profit
accounts for $0.02 per dollar sales revenue.

DOE converted the expenses per dollar sales into expenses per dollar CGS by d ividing

each value in the first data column by $0.74 ( i.e., CGS per dollar of sales revenue). The data in column two show that, for every $1.00 spent on products, the wholesaler allocates $0. 205 to cover labor costs, $0.0 49 to cover occupancy expenses, $0. 07 5 for other operating expenses, and
$0.0 28 in profits. A total of $1.3 57 in sales revenue is earned for every $1.00 spent on products. Therefore, the baseline wholesaler markup ( MU WHOLE BASE ) is 1.357 ($1.357 ÷ $1.00).

DOE also used the data in column two to estimate the wholesaler’ s incremental markup. The incremental markup depends on which of the costs in Table 6.5 -1 are variant and which are invariant with MSP. For example, for a $1.00 increase in MSP, if all the other costs scale with the MSP ( i.e., all costs are variant), the increase in wholesale price will be $1.360 , implying that the incremental markup is 1.360 , or the same as the baseline markup. At the other extreme, if

none of the other costs are variant, then a $1.00 increase in MSP will lead to a $1.00 increase in the wholesale price, for an incremental markup of 1.0. DOE believes that the labor and occupancy costs will be invariant and that the other operating costs and profit will scale with the MSP. In this case, for a $1.00 increase in MSP, the wholesale price will increase to match changes in "other" operating costs and operating profit of $0.076 , which when divided by 73. 76-11

cents in CGS yields an increase of $0. 103

, for a wholesaler incremental markup ( MU WHOLE INCR ) of

1.103

.

6.5.3 Methodology for Contractor Markups

Financial data similar to that used to estimate markups for wholesalers also are available for mechanical and general contractors from the ACCA Financial Analysis 2 and the 2007 Economic Census. To estimate dehumidifier markups specific to mechanical contractors, DOE

collected financial data from the Plumbing and HVAC Contractors (NAICS 23822) series from the 2007 Economic Census. To estimate general contractor markups for dehumidifiers in residential applications, DOE collected data from the Residential Building Construction series from the 2007 Economic Census, which is the aggregation of New Single-Family General

Contractors (NAICS 236115), New Multifamily Housing Construction (NAICS 236116), New Housing Operative Builders (NAICS 236117), and Residential Remodelers (NAICS 236118). ACCA financial data provide GM as a percent of sales for the mechanical contractor industry. Baseline markup can be derived using the following equation.

The U.S. Census data include the number of contractor establishments, payroll for construction workers, value of construction, cost of materials, and cost of subcontracted work at both state and national levels. DOE calculated the baseline markup for mechanical and general contractors using the following equation.

Where:

= baseline markup for mechanical contractor or general contractor,

= value of construction,

= payroll for construction workers,

= cost of materials, and

= cost of subcontracted work.

Analogously, DOE estimated the incremental mechanical and general contractor markups by marking up only those variant costs that scale with a change in the MSP for more energy efficient products. DOE categorized the Census cost data in each major category and used the following equation to estimate markups.6-12

Where:

MU INCR = contractor’ s incremental markup,

CGS CONT = contractor’s cost of goods sold, and

VC CONT = contractor’s variant costs.

6.5.4 Derivation of Markups for Mechanical Contractors

This section d e sc rib es markups for whole-home dehumidifiers applied by the mechanical

contractor. After first presenting aggregate markups, this section divides those markups into categories of replacement and first time owner market.

6.5.4.1 Aggregate Markups for Mechanical Contractors

The 2007 Economic Census provides a Geographic Area series for the Plumbing and

HVAC Contractors (NAICS 23822) sector, which contains national average sale s and cost data, including value of construction, cost of subcontract work, cost of materials, and payroll for construction workers. It also provides the cost breakdown of GM , including labor expenses, occupancy expenses, other operating expenses, and profit. The gross margin provided by the U.S. Census is disaggregated enough that DOE was able to determine the invariant and variant

costs for the sector. By using the equations presented above, DOE estimated baseline and incremental markups, as shown in Table 6.5 -2 . (Appendix 6A.2 contains the full set of data.)

Table 6.5 -2 Mechanical Contractor Expenses and Markups Based on Census Data

Description Mechanical Contractor Expenses and Revenue

Per Dollar

Sales

Revenue ( $ ) Per Dollar

Cost of

Goods ( $ )

Direct cost of product s (CGS) 0.68 1.00 Labor expenses ( salaries [ indirect ] and benefits ) 0.18 0.26 Occupancy expense s ( rent, maintenance, and utilities ) 0.02 0.03 Other operating expenses ( depreciation, advertising, and

insurance ) 0.08 0.12

Net profit before taxes 0.04 0.06

Baseline markup ( MUMECH BASE ): r evenue per $ CGS 1.48

Incremental m arkup ( MUMECH INCR ): i ncreased revenue per $ increase

in CGS 1.18

Source: U.S. Census Bureau. 2007. Plumbing, Heating, and Air-Conditioning Contractors. Sector 23: 238220. Construction: Industry series, Preliminary Detailed Statistics for Establishments . 2007.

The first data column in Table 6.5 -2 provides the CGS and a list of GM components as expenses per dollar of sales revenue. As shown in the table, the direct cost of sales represents about $0.68 per dollar sales revenue to the mechanical contractor, and the gross margin totals6-13

$0.32 per dollar sales revenue. DOE converted those expenses per dollar sales into revenue per dollar CGS by dividing each figure in the first data column by $0.68. For every $1.00 spent on products, the mechanical contractor earns $1.00 in sales revenue to cover the product cost and
$0.48 to cover other costs. The $1.48 in sales revenue earned for every $1.00 spent on product costs is equivalent to a baseline markup ( MU MECH CONT BASE ) of 1.48 for mechanical contractors.

DOE used the data in column two of Table 6.5 -2 to estimate incremental markups, after classifying the costs as either invariant or variant. At one extreme, if all of the other costs scale with the product cost ( i.e., all costs are variant), the increase in mechanical contractor cost will be $1.48, implying that the incremental markup is 1.48, or the same as the baseline markup. At the other extreme, if none of the other costs are variant, then a $1.00 increase in product price will lead to a $1.00 increase in the mechanical contractor price, for an incremental markup of

1.0. DOE believes the labor and occupancy costs are invariant and the other operating costs and profit are variant. In th at case, for a $1.00 increase in product cost, the mechanical contractor ’s price will increase by $1.18

, for an incremental markup ( MU MECH CONT INCR ) of 1.18

.

6.5.4.2 Mechanical Contractor Markups in the Replacement and First Time

Own er Markets

DOE derived the baseline and incremental markups for both replacement and new

construction markets using the 2007 Economic Census industrial cost data 12 supplemented with

the ACCA 2005 financial data. 5 The 2007 Economic Census provides a sufficiently detailed cost

breakdown for the Plumbing and HVAC Contractors (NAICS 23822) sector to enable DOE to estimate baseline and incremental markups for mechanical contractors. The 2007 Economic Census does not separate the mechanical contractor market into replacement and first time owner markets, however. In order to calculate markups for the two markets, DOE utilized 2005 ACCA financial data, which reports GM data for the entire mechanical contractor market and for both the replacement and first time owner markets.

HVAC contractors, defined here as mechanical contractors, reported median cost data in the ACCA’s 2005 financial analysis of the HVAC industry. Those data are shown in Table 6.5 -3.

Table 6.5 -3 Baseline Markup, All Mechanical Contractors

Description Contractor Expenses or Revenue

Per Dollar

Sales Revenue ( $ ) Per Dollar

Cost of Goods ( $ )

Direct cost of product sales (CGS) 0.73 1.00

Gross margin ( labor, occupancy, operating expenses, and profit ) 0.27 0.37

Revenue ( baseline revenue earned per $ CGS ) 1.37

Baseline markup ( MU MECH CONT BASE ) 1.37

Source: Air Conditioning Contractors of America. 2005. Financial Analysis for the HVACR Contracting Industry

.6-14

Table 6.5 -4 summarizes the GM and resulting baseline markup data for all mechanical

contractors who serve the replacement and first time owner markets.

Table 6.5 -4 Baseline Markups for Replacement and First Time Owner Markets

, All

Mechanical Contractors

Description Contractor Expenses or Revenue by Market Type Replacement First Time Owners

Per Dollar

Sales

Revenue ( $ ) Per Dollar

Cost of

Goods ( $ ) Per Dollar

Sales

Revenue ( $ ) Per Dollar

Cost of

Goods ( $ )

Direct cost of product sales (CGS) 0.703 1.000 0.745 1.000

Gross margin ( labor, occupancy, operating expenses, and profit ) 0.297 0.422 0.255 0.342

Baseline m arkup ( MUMECH

CONT BASE ), r evenue per $

CGS NA 1.42 NA 1.34

D ifference compared to

a ggregate baseline markup (%) NA 3.6 NA

- 2.2

Source: Air Conditioning Contractors of America (ACCA) . 2005. Financial Analysis for the HVACR Contracting Industry

.

Using the baseline markup data from Table 6.5 -4 and data from Table 6.5 -3

, DOE

calculated that mechanical contractors ’ baseline markups for the replacement and first time

owner markets for dehumidifiers are 3.6 percent higher and 2.2 percent lower, respectively, than for mechanical contractors serving all markets. DOE applied those markup deviations derived for all mechanical contractors to the baseline markup of 1.48 and the incremental markup of 1.18

estimated in Table 6.5 -2 . DOE assumed that the deviations apply equally to the baseline and incremental markups calculated from the 2007 Economic Census. The baseline and incremental markups for the replacement and first time owner markets served by mechanical contractors are

shown in Table 6.5 -5

.

Table 6.5 -5 Markups for the Replacement and First Time Owner Markets

Market Sector Baseline Markup Incremental Markup Replacement market 1.53 1.22

First time owner market 1.45 1.15

6.5.5 Derivation of Markups for General Contractors

DOE derived markups for general contractors from U.S. Census Bureau data for the

residential construction sector. 13 The residential construction sector includes establishments engaged primarily in construction work, including new construction, additions, alterations, and repairs of residential buildings. The U.S. Census data for the construction sector include detailed

statistics for establishments that have payrolls, similar to the data reported by HARDI fo r wholesalers. The primary difference is that the U.S. Census Bureau reports itemized revenues6-15

and expenses for the construction industry as a whole in total dollars rather than in typical values for an average or representative business. Because of this difference, DOE assumed that the total

dollar values reported by the U.S. Census, once converted to a percentage basis, represent revenues and expenses for an average or typical general contracting business. The first data

column in Table 6.5 -6 summarizes the expenses for general contractors in residential building construction as expenses per dollar sales revenue. (Table 6-A.3 in appendix 6A.3 contains the full set of data.)

Tab le 6.5 -6 General Residential Building Contractor Expenses and Markups

Description General Contractor Expenses

or Revenue

Per Dollar

Sales Revenue ( $ ) Per Dollar

Cost of Goods ( $ )

Direct cost of product sales (CGS) 0.68 1.00 Labor expenses ( salaries [ indirect ] and benefits ) 0.08 0.12 Occupancy expense s ( rent, maintenance, and utilities ) 0.01 0.01 Other operating expenses ( depreciation, advertising, and

insurance ) 0.06 0.09

Net profit before taxes 0.17 0.25 Baseline markup ( MUGEN CONT BASE ), r evenue per dollar cost of goods 1.47

Incremental markup ( MUGEN CONT INCR ), i ncreased revenue per dollar

increase in CGS 1.34

Source: U.S. Census Bureau. 2007. Residential Building Construction . Sector 23: 236115-236118. Construction: Industry

series: Preliminary Detailed Statistics for Establishments : 2007

.

As shown in the first data column , the direct cost of sales represents about $0.68 per dollar sales revenue to the general contractor. Labor expenses represent $0.08 per dollar sales revenue; occupancy expenses represent $0.01 per dollar sales revenue; other operating expenses represent $0.03; and profit makes up $0.20 per dollar sales revenue.

DOE converted the expenses per dollar sales into revenue per dollar CGS by dividing each value in the first data column by $0.68. The data in column two show that, for every $1.00 spent on product costs, the general contractor earns $1.00 in sales revenue to cover the product cost, $0.12 to cover labor costs, $0.01 to cover occupancy expenses, $0.09 for other operating expenses, and $0.25 in profits. A total of $1.47 in sales revenue is earned for every $1.00 spent on product costs of a baseline markup ( MU GEN CONT BASE ) of 1.47.

DOE used the data in column two of Table 6.5 -6 to estimate incremental markups, after classifying the costs as either invariant or variant. At one extreme, if all of the other costs are variant, the increase in general contractor price wo uld be $1.47, implying that the incremental markup is 1.48, or the same as the baseline markup. At the other extreme, if none of the other costs are variant, then a $1.00 increase in product cost leads to a $1.00 increase in the general contractor price, for an incremental markup of 1.0. DOE believes the labor and occupancy costs6-16

are invariant and the other operating costs and profit are variant. In this case, for a $1.00 increase in product cost, the general contractor’s price would increase by $1.34, giving the general contractor an incremental markup ( MU GEN CONT INCR ) of 1.34.

6.6 SALES TAXES

The sales tax comprises state and local taxes applied to the price a consumer pays for a product. The sales tax is a multiplicative factor that increases the consumer product price. DOE applied sales tax to the retail price of portable dehumidifiers and consumer price of whole-home

dehumidifiers in the replacement market, not the first time owner market. The common practice for selling larger appliances such as whole-home dehumidifiers in the first time owner market is that general contractors (or builders) bear the added sales tax for the appliances, in addition to the cost of the units. Therefore, no specific sales tax is necessary to calculate the consumer product price for the first time owner market.

DOE derived state and local taxes from data provided by the Sales Tax Clearinghouse. 14

The data represent weighted averages that include county and city rates. DOE then derived population-weighted average tax values for each RECS region, as shown in Table 6.6-1

.

Table 6.6 -1 Average Sales Tax Rates by Census Division and Large State

RECS Region State(s) Population 2013 Tax Rate ( % )

1 Connecticut, Maine, New Hampshire, Rhode Island,

Vermont 7,904,824 5.13

2 Massachusetts 6,587,536 6.25

3 New York 19,465,197 8.40

4 New Jersey 8,821,155 6.95

5 Pennsylvania 12,742,886 6.40

6 Illinois 12,869,257 8.05

7 Indiana, Ohio 18,061,873 6.87

8 Michigan 9,876,187 6.00

9 Wisconsin 5,711,767 5.45

10 Iowa, Minnesota, North Dakota, South Dakota 9,915,184 6.86

11 Kansas, Nebraska 4,713,879 7.13

12 Missouri 6,010,688 7.20

13 Virginia 8,096,604 5.60

14 Delaware, District of Columbia, Maryland, West Virginia 8,919,645 5.59

15 Georgia 9,815,210 7.10

16 North Carolina, South Carolina 14,335,631 7.00

17 Florida 19,057,542 6.65

18 Alabama, Kentucky, Mississippi 12,150,608 7.25

19 Tennessee 6,403,353 9.456-17

RECS Region State(s) Population 2013 Tax Rate ( % )

20 Arkansas, Louisiana, Oklahoma 11,304,323 8.67

21 Texas 25,674,681 7.95

22 Colorado 5,116,796 6.10

23 Idaho, Montana, Utah, Wyoming 5,968,564 5.29

24 Arizona 6,482,505 7.20

25 Nevada, New Mexico 4,805,546 7.31

26 California 37,691,912 8.45

27 Oregon, Washington, Alaska, Hawaii 12,799,425 5.30
Population

- w eighted a verage 7.146

6.7 OVERALL MARKUPS FOR DEHUMIDIFIERS

The overall markup for each distribution channel is the product of the appropriate markups, as well as the sales tax in the case of direct consumer purchases of portable dehumidifiers and replacement market of whole-home dehumidifiers.

DOE used the overall baseline markup to estimate the consumer product price of baseline models, given the manufacturer cost of baseline models. As stated previously, DOE considers baseline models to be products sold under current market conditions ( i.e., without new energy conservation standards). The following equation shows how DOE used the overall baseline

m arkup to determine the product price for baseline models.

Where:

CPP BASE = consumer product price for baseline model,

COST MFG = manufacturer’s cost for baseline model,

MU MFG = manufacturer’s markup,

MU BASE = baseline markup for portable dehumidifiers and whole-home

dehumidifiers (replacement and new home markets),

Tax SALES = sales tax (portable dehumidifiers and replacement market of whole-home

dehumidifiers ), and

MU OVERALL_BASE = overall baseline markup.

Similarly, DOE used the overall incremental markup to estimate changes in the consumer product price given changes in the manufacturer cost resulting from an energy conservation

standard. The total consumer product price for more energy efficient models comprises two components: the consumer product price of the baseline model, and the change in consumer product price associated with the increase in manufacturer cost to meet the new energy conservation standard. The following equation shows how DOE used the overall incremental

m arkup to determine the consumer product price for more energy efficient models.6-18

Where:

CPP STD = consumer product price for models that meet new energy conservation

standards,

CPP BASE = consumer product price for baseline model,

COST MFG = manufacturer’s cost for baseline model,

Δ COST

MFG = change in manufacturer’s cost for more energy efficient models,

MU MFG = manufacturer’s markup,

MU INCR = incremental markup for portable dehumidifier and whole-home

dehumidifiers (replacement and new home markets),

Tax SALES = sales tax (portable dehumidifiers and replacement market of whole-home

dehumidifiers), and

MU OVERALL_BASE = overall baseline markup (product of manufacturer markup, and

MU OVERALL_INCR = overall incremental markup.

National average baseline and incremental markups for both portable and whole-home

dehumidifiers are summarized in Table 6.7 -1 and Table 6.7 -2

, respectively.

Table 6.7 -1 Summary of Markups for Portable Dehumidifiers

Markup Baseline Incremental

Manufacturer 1.43

Retailer 1. 36 1.1 1

Sales t ax 1.0 7 1

Overall 2.08 1.70

Table 6.7 -2 Summary of Markups for Whole-Home Dehumidifiers

Markup Replacement First Time Owner

Baseline Incremental Baseline Incremental

Manufacturer 1.43 1.43

Wholesaler 1.36 1.10 1.36 1.10

Mechanical c ontractor 1.53 1.22 1.45 1.15

General c ontractor

-- -- 1.47 1.34

Sales t ax 1.071

-- --

Overall 3.19 2.06 4.15 2.426-19

REFERENCES

1. U.S. Department of Energy: Energy Information Administration, Residential Energy Consumption Survey: 2009 RECS Survey Data, 2013. (Last accessed March, 2013.)

< http://www.eia.gov/consumption/residential/data/2009/ >

2. Association of Home Appliance Manufacturers, AHAM 2009 Fact Book . 2009. Washington, DC.

3. U.S. Census Bureau, 2007 Annual Retail Trade Survey, Electronics and Appliance

Stores. 2007: Washington, DC. http://www.census.gov/retail/arts/historic_releases.html

4. Dale, L. and K. Fujita, An Analysis of Price Determination and Markups in the AirConditioning and Heating Equipment Industry , January 2004.

5. Air Conditioning Contractors of America (ACCA), Financial Analysis for the HVACR Contracting Industry: 2005, 2005. <https:// www.acca.org/store/product.php?pid=142 >

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< http://www.hardinet.org/Profit -Report >

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Establishments: 2007

. 2007< http://www.census.gov/econ/ >

10. U.S. Census Bureau, Data set for Sector 23, EC0723A1: 238220 (Plumbing, Heating and Air-Conditioning Contractors), Construction: Geographic Area Series, Detailed Statistics for Establishments, 2007. < http://www.census.gov/econ/ >

11. Pindyck, R. S. and D. L. Rubinfeld, Microeconomics . 5th ed. 2000. Prentice Hall: New Jersey.

12. U.S. Census Bureau, Plumbing, Heating, and Air-Conditioning Contractors. Sector 23: 238220. Construction: Industry Series, Preliminary Detailed Statistics for
Establishments, 2007, 2007. < http://www.census.gov/econ/ >6-20

13. U.S. Census Bureau, Construction: Industry Series: Preliminary Detailed Statistics for Establishments: 2007. New Single-Family General Contractors, New Multifamily Housing Construction (Except Operative Builders), New Housing Operative Builders,
and Residential Remodelers, 2007. < http://www.census.gov/econ/ >

14. Sales Tax Clearinghouse Inc., State Sales Tax Rates Along with Combined Average City and County Rates, 2013. (Last accessed September 11, 2013.)

< http://thestc.com/STrates.stm >